Here we go again folks…
As I write this, the US markets are down around 3% overnight and the FTSE is just opening down by 1.5%. What an incredible week.
I must admit I’ve been mesmerised by it all from a trading perspective and a study into human psychology.
Amidst all this, I’ve been writing the latest edition of What Really Profits and boy there’s never been a more interesting time to write a publication focused on trading & short term investing.
This month I include an article on trend trading and how to use the ADX indicator as part of a traffic light system to fine tune your trading decisions. People often focus on when to get in on a trade, but I often find it very useful to also look at inputs that will stop you entering trades.
I’ve also taken a good look two promising pieces of trading software this month. Both Colour Charts (Gravity bar) software from Click The Market and INO’s Market Club have been on the watchlist for some while.
I’ve also sampled Larry William’s commodity timing newsletter. I’m quite a fan of his work so was pleased to find his newsletter to be a valuable offering. Speaking of value, the $70 Forex Backlash system also gets the WRP treatment. You’ll have to read the full review to get the complete picture, but at the very least it introduced me to a promising chart set up that I’d never heard of before.
I apologise if it’s taken longer than usual to reply to your emails. It’s been a busy old week to say the least. Please do keep your questions and feedback coming. Your emails and questions give me a good steer on what to focus on in the Market Maven and What Really Profits newsletters, so keep in touch!
It’s soapbox time. I’ve been incredibly annoyed by some of the newspaper reports and politicians over the last few weeks. There’s been an inordinate amount of commentary on short selling and hedge funds from people who’ve no idea of what they’re talking about. If you believed the papers, you’d have thought that short selling is a one-way bet. I can tell you from painful experience it is not. So who or what is to blame for the financial crisis – for me, it all stems from bad control of financial leverage.
Who’s to blame? The misjudgement of financial leverage
The recent crisis is down to foolish trades in sub prime mortgages and over leverage. I say foolish because traders and hedge fund managers not stupid. Many of them have degrees from top international Universities, but being clever and being wise are two different things. Sir Isaac Newton, arguably one of the smartest men in history was a fool when it came to money. During the South Sea bubble he was in charge of the mint, putting him in an approximate position of head of the bank of England. Yet he lost a lot of his own money speculating on the South Sea bubble. He sensibly booked his profits on the way up, then prices kept on accelerating he jumped back in, fearing he’d be been premature. He had timed the top almost to perfection and lost more money than he’d previously made.
The real culprit was over in the recent crisis isn’t even foolish trades, it’s over leverage.
The biggest single reason that traders blow their account is leverage. A small point movement can lead to huge gains, but it can also lead to large losses. I cannot express enough the importance of understanding just how dangerous leverage can be. Leverage refers to the amount of money your trade is worth in comparison to the amount of money you have in your account. With spread betting you can start with a few hundred pounds, but you would be playing with fire because you would have hardly any room to place your stops at a decent distance away from the price before being stopped out and possibly wiping out your account.
It is no coincidence that the biggest collapses in trading history are down to over leverage. The credit crunch is arguably not down to bad investments in sub prime assets, but over leverage. If banks had allocated smaller amounts of their capital to sub prime trades, they wouldn’t be in this mess. They would be losses for sure, but they wouldn’t be as disastrous.
Until 2004 the maximum US broker dealers debt to net capital ratio was 12 to 1. An exemption that year gave 5 firms the ability to lever up to 30 and even 40 to 1. You will not be surprised to hear that those brokers were Merrill Lynch, Lehman Brothers, Bear Stearns, Morgan Stanley and Goldman Sachs. Just three of these firms still exist as they did 12 months ago and at the time of writing, the last two are in merger/ takeover talks. The last financial crisis revolved around the collapse of hedge fund Long Term Capital management. It went bust because it was massively over leveraged on natural gas futures. Northern Rock was over leveraged in terms of the amount of money it was lending out in relation to the amount of money it had in deposits.
Short sellers
I’ve been speaking to my friends in the city (the ones who still have jobs) and it is clear that the short sellers definitely had a role in the extreme panic of last week. The problem wasn’t short selling per se, but it certainly contributed to the overall panic at the time. The effects of short selling financial stocks appear to be a system of the problem not the cause. The problem is lack of transparency. No-one trusted the banks on their true exposure to subprime so rumour mongering was rife. Last week was all about rumour, what the other guy might know that you don’t. If a hedge fund manager wanted to short HBOS for 5 million shares, the guy at the other end was thinking “what the hell does he know that I don’t?” and duly pulled the price before he’d let him trade.
The solution is greater transparency in accounting procedures for complex derivatives so that everyone has a better idea of who is exposed to what and greater transparency with shorting. Shorting needs to have the same level of checks and paper trail as long trades.
Although it goes against my libertarian instincts, I would argue that the FSA was right to ban short selling in financial stocks last week, because according to my banking contacts, we really were on the brink last week. I believe Hector Sants, the head of the FSA when he said markets had become inefficient. If RBS had gone down, 80% of public sector workers wouldn’t have got their pay on time. It was a case of throwing whatever you could at it to stop the turmoil. However, it is very wrong to blame short sellers for all the mess, or to keep the ban on for as long as they plan. Short selling isn’t the problem and extending the ban isn’t the solution. The pop on Friday wasn’t all due to ban on short selling, it was due to the US bail out plan which is more worrying.
Banning short selling isn’t a panacea. The last time short selling was banned in 1930, the Dow Jones popped on the news then rolled over and dropped by half nearly. A similar thing happened when the Pakistan stock exchange banned short selling. Larry Williams has an interesting video on it all here: http://www.ireallytrade.com/TVStation/LarryTV.html. There’s also an interesting piece on the Big Picture blog which quotes the New York Times from 1930. Short sellers were again getting the blame.
http://bigpicture.typepad.com/comments/2008/09/short-selling-o.html
Prizes up for grabs
I’m looking for the best reader reviews of trading systems and tipsheets you’ve used. In particular I need as much information as possible on the your experience with training events held by Greg Secker, Darren Winters, Vince Stanzione or another big name trader.
I’ve had some great replies so far and there are some early front runners. The winner will get a copy of Malcolm Pryor’s excellent book on spread betting as well as some mystery prizes from my collection of trading systems (The market Maven cupboard is bulging at the moment). I’ll organise a runner up prize too. Send in your experiences, no matter how brief, I’m sure they’ll be useful.
System watch
A few more ClickBank systems are doing the rounds and Forex Tracer has been promoted by a few people recently. It looks very similar to Forex Auto Pilot and Forex Killer in the way the website is presented, but I believe they are from different people. The system is relatively cheap at $97, but is this money down the drain?
Unfortunately, it appears to be so. The promo page has a picture of an automated test report showing profits of over $335,000 between June 2006 and May 2008. The problem with backtests is that they can be optimised. For example if you had a designed a system that went short the Dow Jones this year, you might be making a killing, but it wouldn’t necessarily make a profit every year. For a system to be tested properly, it needs to be proven to work in different market conditions. Forex Tracer appears to be optimised for the period shown on the test report. When you run a back test on the system through different periods, 2006 showed a loss overall and 2005 would have wiped out a $10,000 account. 2007 was undoubtedly superb, but 2008 basically stopped working in… you guess it, May, the time the test extends to.
Having a system stop working when it worked previously for many years is unfortunate but understandable. But cherry picking results from the years that work is just wrong.
On a more positive note, I’ve been asked to look into FX Money Map (http://www.fxmoneymap.co.uk) from Andy Sherman. It costs a fair whack, but the question as ever is whether this represents value. Considering a cost of around £2,500 + $199 in data fees, you’d better hope it makes money. Fortunately in my experience and based on the feedback of a good contact, it does work. The trader I know trades
GBP/ USD first thing in the morning using the Money Map methods and does rather well. I must note that he does also use his own filter based on weighting all the currencies against each other and his own experience regarding which currencies trade well when others are low. If you’re considering a purchase I suggest you attend one of this online seminars and if possible go visit him. There’s no money back guarantee as far as I’m aware so you need to make sure you make a purchase you’re comfortable with if you think it looks attractive.
Secret Flag Trader (http://tinyurl.com/47sdg5) is creating some interest. It’s from Guy Cohen, the guy behind Illuminati Trader. The core part of the Illuminati Trading system was the flag pattern (More on flag patterns here: http://tinyurl.com/2y7was). Unfortunately it seems that the recent market volatility has made Guy’s options based volatility strategy slightly unworkable due to options premiums becoming more expensive. However, he was apparently finding that his members were making good money trading flag patterns anyway using spread betting for example, so he launched Flag Trader. The Secret Flag Trader program goes through Guy’s derivation of the flag pattern and perhaps most importantly includes his custom software that searches for the best set ups for you. I’ll be doing a full review in the next edition of
WRP. On first skim, it looks to be professionally presented, but I need more time to determine its true value.
Free system with 96% strike rate: The excellent Quantifiable edges blog has a neat little shorting system (still allowable on markets other than financial stocks) which has been doing very well in the current environment. Full details here: http://quantifiableedges.blogspot.com/2008/08/short-system-for-handling-chop_28.html
and update here: http://quantifiableedges.blogspot.com/2008/09/when-market-does-what-market-doesnt-do.html
Please note, it is not profitable long term, but looks like it might work very well in choppy trading environments specifically.
Entry Criteria:
1) The S&P 500 closes higher 2 days in a row AND
2) The S&P closes below its 200-day moving average then sell short on close.
Exit Criteria:
1) If the S&P closes under the entry price of the trade, cover on close
OR
2) Cover on the close of day 4 if not profitable.
96% strike rate since January 2007.
My trades
I made a nice long trade on the S&P 500Thursday as the panic reached extreme levels. All may contrarian indicators hit extreme levels. The VIX options volatility index had spiked and the 3 month treasury bonds hit rock bottom. 3 month treasuries as supposedly the safest place for your money in the short term. People looking to hoard cash couldn’t put it in a bank because, well, which bank would you put it in? On Thursday, for me it was either all out collapse or a big pop. It went against me to start with, but I went in very small and closed it at the close. Other than that I’ve been keeping well out of any trading, partly because I’ve had no time for intraday trades with writing the latest edition of WRP and partly because it’s just been too wild.. It looks as though some interesting moves are developing on the Dollar so I’ll be getting back in the saddle soon.
This week’s hot trading buttons
Next week’s headlines will be dominated by Ben Bernanke’s testimony before congress starting on Wednesday. We also have US existing home sales on Wednesday and new home sales on Thursday. However, the planned economic announcements could be secondary to any surprise headlines or further news on the bail out plan from the Bush Government. When stock markets move percentage points in the matter of minutes, anything can happen.
Trading wisdom
“Learn from yesterday, live for today, hope for tomorrow. The important thing is not to stop questioning.” Albert Einstein
